Private equity refers to investment funds that buy, manage, and restructure companies not publicly traded on stock exchanges like the NYSE or Nasdaq. Unlike public equity, which is accessible to general investors via stock markets, private equity is typically available only to institutional investors and high-net-worth individuals due to its high minimum investments and long-term commitment.
How Private Equity Works
Private equity firms raise capital from “Limited Partners” (LPs) such as pension funds, university endowments, sovereign wealth funds, and wealthy individuals. The firm, acting as the “General Partner” (GP), uses this pooled capital to acquire companies that are undervalued or underperforming, often taking a controlling interest.
Once acquired, private equity firms take an active, hands-on role in improving operations, strategy, and financial structure. This involvement can include streamlining processes, replacing management, cutting costs, or investing in growth initiatives. Firms often use leverage (borrowed money) to boost returns but this also increases risk.
After a typical holding period of 3 to 7 years (within a fund lifespan of around 10-12 years), private equity firms exit these investments through strategies like selling to strategic buyers, conducting an Initial Public Offering (IPO), or selling to another private equity firm. Profits are distributed to LPs and the GP after deducting fees.
Private Equity vs. Public Equity
Public equity involves buying shares of companies traded on public stock exchanges, offering liquidity, transparency, and accessibility to everyday investors. Private equity, by contrast, involves illiquid investments with less transparency and requires significant capital and a long time horizon. It offers more control and potential for active improvements but comes with higher fees and risks.
| Feature | Private Equity | Public Equity |
|---|---|---|
| Accessibility | Limited to institutional and high-net-worth investors | Open to all investors via brokerage accounts |
| Liquidity | Low—funds locked for years | High—shares traded daily |
| Transparency | Limited financial disclosure | Regular, comprehensive reporting |
| Control | Significant, often majority control | Minimal for individual shareholders |
| Time Horizon | Long-term, usually 3–10+ years | Variable, flexible |
| Fees | High management and performance fees | Low brokerage fees and fund expenses |
| Valuation | Infrequent, complex private valuations | Daily market-driven pricing |
Who Invests in Private Equity?
Primary investors are institutional LPs looking for diversification and higher returns, including pension funds, university endowments, sovereign wealth funds, insurance companies, and high-net-worth individuals. The PE firms (GPs) actively manage the investments and charge fees for their expertise.
Private Equity’s Role and History
Modern private equity evolved post-World War II, notably through venture capital funding of startups in the 1950s and 1960s. The 1980s popularized leveraged buyouts (LBOs), where firms used debt to acquire established companies, often restructuring them intensively. Today’s PE industry is a multi-trillion-dollar global sector employing diverse strategies beyond LBOs, including growth equity and distressed asset investing.
Real-World Examples
Companies like Burger King, taken private by 3G Capital, and Dell Technologies, which went private with Silver Lake Partners, showcase how PE firms can transform businesses. However, some PE buyouts, such as Toys “R” Us, demonstrate risks including bankruptcy after acquisition.
Benefits and Risks
Benefits: Potentially higher returns due to active management, use of leverage, and illiquidity premium; portfolio diversification; unique investment opportunities.
Risks: Common risks include illiquidity (funds locked for up to 12 years), high fees (management plus carried interest), less transparency, use of high leverage, and long investment periods.
Is Private Equity Right for You?
Direct private equity investing is generally inaccessible to most individuals due to high minimums and complexity. High-net-worth investors may access PE through feeder funds or wealth platforms, but it requires careful evaluation of risks and fees. Most individual exposure to private equity comes indirectly via pension plans or endowments.
Additional Resources
Learn more about related investment topics like Accredited Investors, Capital, and Time Horizon.
For detailed guidance, visit the IRS Private Equity Overview or consult a financial advisor to determine if private equity fits your investment plan.